Question

Sensitivity of the Terminal Value Calculation

Use the formula for the terminal value of CAPM. The growth rate of cash flow in the note is assumed to be constant at g. Thus, the cashflow estimate of t+6 is the cashflow of t+5 multiplied by (1+g) and so forth. Now, suppose the estimated cashflow of t+5 is $1,000,000. Discount rate is 6%. Given this information, answer the following question.

a) Suppose g=2%. What is the terminal value measured at t+5?

b) If g=4%, what is the terminal value measured at t+5? How large is this value in terms of the % of the original value in a)?

c) If discount rate is adjusted to 5% and if we assume g=4%, what is the terminal value? How large is this value in terms of the % of the original value in a)?

Answer 1

1.
What is the terminal value measured at t+5?
=1000000*1.02/(6%-2%)=25500000

2.
What is the terminal value measured at t+5?
=1000000*1.04/(6%-4%)=52000000

How large is this value in terms of the % of the original value in a)?
=52000000/25500000
=203.9216%

3.
What is the terminal value?
=1000000*1.04/(5%-4%)=104000000

How large is this value in terms of the % of the original value in a)?
=104000000/25500000=407.8431%